An emergency lending program would keep a liquidity crisis from turning into a solvency crisis.
The policy pronouncements and tools used in 2008 by Federal Reserve Chairman Ben Bernanke and his crisis-fighters weren’t designed to address the current threat. Yet Chairman Jerome Powell fired a 2008-style barrage Sunday evening.
Cutting interest rates to near zero, purchasing hundreds of billions of long-term Treasury bonds and agency securities, making commitments to hold rates down for a long time—the monetary arsenal of 2008-09—will likely be of only modest help this time around. The old weapons must be paired with new ones fit for the 2020 pandemic.
The novel coronavirus has been moving faster than the world’s economic policy makers, threatening to shut down the global economy as it approaches. Yet the Fed possesses powerful untapped authority, and with the help of Congress and the administration there is much it can do to improve economic prospects.
U.S. public-health officials acknowledge that the window to contain the virus has passed. They have pivoted to a policy of mitigation, trying to buy time so that the health-care system can manage the influx of cases. Economic policy makers must make an equally forceful pivot to save the economy from a deep and painful recession.
In consultation with the Treasury secretary and congressional leaders, the Fed should immediately invoke its emergency powers under Section 13(3) of the Federal Reserve Act and establish a new credit facility to ensure that sound businesses and households have ready access to cash to get through the crisis.
A new Government-Backed Credit Facility, or GBCF, would require everyone to have skin in the game: all parts of the government, all institutions in the banking system, and a broad cross-section of small businesses, large corporations and households.
The Fed board of governors would authorize the program and ensure its accord with Walter Bagehot’s dictum: lend freely to solvent firms and individuals on good collateral at interest rates higher than are customary.
Thousands of regulated banks would be on the front lines. They would underwrite loans based on the quality and value of collateral and the expected cash flows of borrowers, evaluating applicants based on their credentials as of Jan. 1, before the pandemic. Borrowers would need to demonstrate that they are unable to obtain credit elsewhere but are solvent, consistent with the requirements of the Federal Reserve Act.
The 12 geographically dispersed banks in the Federal Reserve system would judge whether the loans underwritten in their region pass muster. The New York Fed would evaluate each package of loans, and price them at spreads modestly higher than would be customary in normal times.
Loans would be for a term of up to 90 days, subject to renewal as long as the virus is affecting the economy. The GBCF would have a maximum life of 18 months. If the virus dissipates quickly, the Fed’s program would be wound down quickly as well.
The president could authorize the Treasury secretary to use funds from the Exchange Stabilization Fund to kick-start the program by providing assurance to the Fed that there is sufficient collateral to support it. Crucially, Congress would also authorize a fiscal backstop to offset any loan losses incurred by the Fed or the banks themselves. These actions would maintain an appropriate line between monetary and fiscal policy.
The establishment of the GBCF is the right response to this crisis. The economy was fundamentally strong and prospects were promising before the onset of the pandemic. U.S. households’ earnings were growing at the highest rate in decades, and the household savings rate was high. Business profit levels remained strong, and the banking system was sound.
Owing to the virus, many U.S. households and businesses are expected to face a liquidity crisis. It must be managed quickly and effectively so it doesn’t turn into a solvency crisis. More traditional Keynesian fiscal stimulus to spur immediate consumer spending is at odds with the public-health measures adopted by the president to slow economic activity for a time.
In 2008, I recall sitting along the wall of the Roosevelt Room at the White House. Mr. Bernanke and Treasury Secretary Henry Paulson sat at the main table across from President George W. Bush. They were seeking the president’s support for a set of extraordinary policy moves to help the U.S. economy survive the financial crisis. Mr. Bush listened intently, and before granting his approval, he said something that caused me to take particular note. In paraphrase: “When this is over, you guys better think hard how this all happened and why we were all so unprepared. No one sitting in these chairs again should find themselves with so few options.”
Policy makers should have used the long period after the financial crisis to give more consideration to the eternally salient question: What could possibly go wrong? But now is no time for navel gazing, or cutting and pasting the response from the last crisis. Policy makers should move with dispatch and confidence to a new paradigm to respond to a different kind of economic shock.
At a time of government dysfunction and division, pettiness and partisanship, the Fed would be wise to lead the effort, consistent with its mission as lender of last resort, with support and backstop funding from the administration and Congress.
Mr. Warsh, a former member of the Federal Reserve Board, is a distinguished visiting fellow in economics at Stanford University’s Hoover Institution.
